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RSM219H1 (136)

Ch 9 Current Liabilities.docx

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University of Toronto St. George
Rotman Commerce
Martin Ralph

Ch 9 Current Liabilities, Contingencies and Commitments 11/04/2013 2:24:00 PM • Liabilities represent the company’s obligations arising from past transactions or events - Represents a duty, responsibility, or obligation that imposes an economic burden - Enforcement; the entity has little or no discretion to avoid the obligation . The creditor has the right to pursue legal action - Obligation exists at the present time. The exact amount may not be determined until a later event has occurred, but the underlying transaction or event creating the obligation has already occurred. • Contingent liability : the liability has not been recorded in the accounts, because the obligation is conditional, dependent, or contingent on the occurrence of a low-probability. • Mutually unexecuted contract is not recorded in the accounting system because both parties have not performed their part of the contract • Partially executed contract : one in which one party has performed part of all of its obligation Valuation Methods for Liabilities 1) Present Value 2) Gross amount of the obligation: the total amount of payments to be made; - May not adequately measure the obligation - If the rental agreement can be cancelled at any time, the company is only obligated to pay the current amount - It ignores the time value of money since interest only accrues as an obligation as time passes, the only liability that exists is for the principal of the loan. 3) Net Present Value of the obligation -Recognizes the amount of the obligation in its net present value. As time passes, interest expense is recorded which recognizes the cost of the loan and increases the liability -Future payments of principal and interest are discounted back to the current period using a discount rate Canadian Practice: - Record liabilities at the present value of the future payments - Short-term liabilities is recorded as the gross amount because the difference in the amounts would not be material Current Liabilities Related to Operating Activities 1. Accounts Payable  Generally does not have interest charges  Discount for early payments or penalty doe late payments  Called trade accounts payable 2. Wages & other payroll liabilities  Fringe Benefits : pension plan, medical insurance, union dues, vacation pay must be recognized.  must accrue wages earned since the last pay period  Company acts as government agent in collecting taxes , keep track of the amounts deducted from employees’ earnings and report a liability to pay these amounts to the government 3. Corporate Income Tax  Companies are subject to Federal corporate income taxes
 & Provincial corporate taxes  Payment of taxes does not always coincide with the incurrence of the tax  Most companies are required to make installments based on the previous years’ tax payable 4. Warranty Obligations  The sale of goods or services sold may result in implicit or explicit guarantees to the buyer  Warranty service is included in the price of the product  To satisfy the matching principal, a warranty expense and a warranty liability must be recognized, based on an estimated future cost using past history of claims. Warranty expense (SE) 3,000 Estimated warranty (L) 3,000  W.E. is recorded as an expense in the year of sale whereas the portion of the obligation that is expected to be settled will be grouped into current or noncurrent liabilities. Estimated warranty (L) 1,700 Cash (A) 1,700   No expense is recorded when actual warranty costs are incurred; the warranty liability is debited  If it’s not recorded in the same period, the profit would be overestimated.  IFRS have moved towards measuring warranty obligations as the sales value of the warranty service rather than the company’s cost to provide it. 5. Unearned Revenues  Deposits or down payments aka unearned revenues, deferred revenues  In the liability section because by accepting the money in advance, they incur an obligation to provide the related goods or services  Revenue is recorded when they delivery the goods/services 6. Gift Certificates and Prepaid Cards  Revenue is recognized only when the cards are redeemed for goods or services  When a card is sold, the company records the cash received and an offsetting liability – an obligation to provide goods and services Cash (A) 10,000 Unearned Revenue (L) 10,000 Unearned Revenue (L) 2,000 Sales (SE) 2,000 Costs of goods sold (SE) 1,500 Inventory (A) 1,500 7. Customer Rewards & Loyalty Programs  Similar to those with warranty obligations  Estimate the cost of the free goods and services that it provides in the future, and accrue this as an expense in the period when the sales revenue was recorded . Credit to a liability account and debit it while customers redeem them.  Recent standards under IFRS have moved towards measuring loyalty program liabilities as the sales value 
 of the goods or services that will be required to satisfy 
 the reward redemptions, rather than
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